Purchase Timing a Wall to Facebook Derivative Litigation Despite Unenforceability of Forum Selection Clause

Four derivative lawsuits against Facebook’s directors relating to alleged disclosure issues surrounding the company’s initial public offering have a new status: Dismissed. Last month, Judge Robert Sweet of the Southern District of New York dismissed the suits on standing and ripeness grounds, finding that IPO purchasers have no standing to pursue claims related to alleged misconduct that took place before the IPO. The dismissed derivative suits were “tag-along” actions that largely parroted allegations made by investors in a parallel securities class action also pending before Judge Sweet, and had sought to hold Facebook’s directors liable for damages the company might incur as a result of the securities class action.

In dismissing the suits, Judge Sweet held that plaintiffs who buy stock in an IPO lack standing to pursue derivative claims based on alleged misstatements in an IPO registration statement. As Judge Sweet explained, in order to have standing to sue derivatively on behalf of a company, a plaintiff must have owned stock in the company at the time of the alleged misconduct. The registration statement that the plaintiffs allege to have been misleading, however, was finalized and filed with the SEC two days before the IPO. Judge Sweet rejected plaintiffs’ attempts to create standing by arguing that the wrong continued through the date of the IPO because the directors did not correct the allegedly misleading statements by that date.

Judge Sweet also held that plaintiffs’ claims were not ripe because the alleged damages had not yet been incurred. Judge Sweet described the derivative cases as essentially placeholder indemnity actions that sought damages from Facebook’s directors for any injury the company might suffer in the future as a result of any money judgment entered against it in the parallel securities class action. Judge Sweet held that since the alleged damage to Facebook was contingent on the outcome of the securities class action, plaintiffs’ derivative claims were not ripe and must be dismissed.

Finally, Judge Sweet held that the forum selection provision of Facebook’s charter, which requires shareholders to bring derivative suits in the Delaware Court of Chancery, was unenforceable as to IPO purchasers like plaintiffs, even though the provision was adequately disclosed to plaintiffs, and was adopted by the company’s board and approved by its pre-IPO stockholders prior to the IPO in accordance with Delaware law. Facebook, however, did not file its charter with the Delaware Secretary of State until four days after the IPO. Judge Sweet found that, under Delaware law, the charter did not become effective until that date and thus the plaintiffs, who purchased during the IPO, were not bound by the charter’s exclusive forum provision.

Judge Sweet’s holdings on standing and ripeness will undoubtedly help other companies obtain early dismissal of tag-along derivative suits, particularly those focused on IPO-related conduct. In addition, his holding regarding Facebook’s charter provides a useful reminder to companies preparing to go public of the steps that must be taken before a charter, and any forum selection provision therein, can become effective.

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